Alternative Investment Intelligence

Underwritten gross, owned net

Hedge funds, private credit and private equity are sold on gross performance and held by families who are taxed. The distance between the two numbers is the subject of this area.

Start with hedge funds

Part of Wealth Intelligence.

Where the return goes

Gross strategy returnMarketed

Management and performance feesDisclosed

Financing and transaction frictionEmbedded

Tax on distributions and allocationsInvestor's

Realised

What the family actually banks

Only the first line is comparable across managers without adjustment.

The premise

Alternatives are underwritten gross and owned net

Institutional allocators — endowments, pensions, sovereign funds — largely do not pay tax on investment return. The performance record of the alternatives industry was built by and for those investors, and the vocabulary of the industry reflects it.

A taxable family adopting the same allocation inherits the strategy and the fee load, but not the tax position. A strategy that is excellent for an endowment can be ordinary for a family, not because it performs differently, but because a meaningful part of its return is delivered in a form that is taxed annually and at unfavourable rates.

This area does not argue against alternatives. It argues for underwriting them in the currency the owner is actually paid in.

The core observation

The more active the strategy, the more of its return is taxed at the least favourable rate

Which means the strategies most likely to justify a high fee are often the ones a taxable investor keeps the least of.

Hedge funds

Why character decides the outcome

Four deductions stand between a hedge fund's reported return and a taxable family's realised one. Each is measurable; none is usually presented together with the others.

Layer 1

Management fee

Charged on assets regardless of outcome. Straightforward, disclosed, and the smallest of the four in most years with positive performance.

Layer 2

Performance fee

Charged on gains, subject to hurdles and high-water marks that vary by manager. Asymmetric: the manager shares the upside and not the downside, so the investor's compounded return diverges from the strategy's over time.

Layer 3

Financing and friction

Borrowing spreads, short rebates, transaction costs and, in fund-of-fund structures, a second fee layer. Rarely itemised to the investor, and visible mainly as the residual between strategy and net returns.

Layer 4

Tax

Frequently the largest deduction for a taxable investor, and the only one the manager has no obligation to consider. Active strategies tend to generate income and short-holding-period gains, both generally taxed less favourably than long-term gains.

The Hedge Fund X-Ray instrument is being built to run these four layers on a specific fund's disclosed terms, so that two managers can be compared on the number the investor keeps rather than the number the manager reports. Where the conclusion is that a strategy is worth owning but not worth owning directly, the structural response is examined in hedge fund strategies inside PPLI.

Private credit

Stated yield is not received yield

Private credit is presented as a yield product, and yield is the most misleading headline number in the asset class. A stated coupon is a gross, pre-loss, pre-fee, pre-tax figure. What reaches a taxable investor is that figure less management and performance fees, less realised credit losses across the cycle, less any drag from undrawn capital and fund-level leverage costs, and less tax.

The tax point is structural rather than incidental. Private credit's return is predominantly interest. Interest is generally taxed as ordinary income in the year it arises, with no deferral and no preferential rate — the least favourable combination in the tax code of most developed jurisdictions. A double-digit stated yield and a mid-single-digit realised after-tax yield are not a contradiction; they are the normal relationship.

This does not make private credit unattractive. It makes the comparison to public fixed income, which is usually drawn on stated yields, the wrong comparison. Private Credit Real Yield is being built to draw it correctly.

Private equity and venture

Long horizons, favourable character, opaque marks

Tax character

Generally the most favourable of the three: return arrives as long-term capital gain on exit, and the multi-year holding period is a deferral mechanism that occurs naturally rather than by design.

Fee load

Among the heaviest, and complicated by carry, fee offsets, deal fees and the difference between committed and invested capital. Reported IRRs are sensitive to assumptions the investor cannot audit.

Valuation

Interim marks are estimates, not prices. A portfolio that reports low volatility because it is not repriced is not less risky — it is less observed, which is a different property with different consequences for allocation.

Instruments

Tools being built for this area

Hedge Fund X-RayFees, financing and tax character applied to a fund's own disclosed termsIn development → Private Credit Real YieldStated yield against after-loss, after-fee, after-tax yieldIn development → PPLI Economics and Break-EvenWhen holding a strategy inside a structure repays the structure's costIn development →

Common questions

Questions this area answers

What do hedge funds return after fees and taxes?

There is no single figure, and any source offering one is averaging across strategies, vintages and tax positions that are not comparable. What can be done is to take a specific fund's disclosed fee terms, its strategy's typical income character and turnover, and the investor's own applicable rates, and produce a net figure for that combination. That is what the Hedge Fund X-Ray is being built to do.

How is private credit taxed?

Predominantly as ordinary income, because the return is predominantly interest. Original issue discount and payment-in-kind features can accelerate recognition further, taxing an investor on income received in the form of more paper rather than cash. Treatment varies by jurisdiction, by vehicle and by whether the fund is domestic or offshore to the investor — which is why the analysis has to be run on the specific structure rather than the asset class.

Does this mean a family should avoid alternatives?

No. It means the allocation decision should be made on after-tax expected return, not gross. Some strategies survive that adjustment comfortably. Some do not. And for some, the honest conclusion is that the strategy is worth owning but not worth owning in a directly taxable form — which is a structural question rather than an investment one.

Where does PPLI come into this?

Only where the arithmetic supports it. A compliant insurance structure can change the tax treatment of assets held inside it, which matters most for exactly the strategies that are least tax-efficient to hold directly. It also has real cost and real constraints, including limits on investor control. Whether the benefit exceeds the cost is a calculation, set out in Wealth Structure Intelligence and in PPLI costs and economics.

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